When Bob Lawless introduced me a couple of weeks ago, he promised that I would stir up trouble. If responses to my post on amending the Bankruptcy Code to permit states to file are any indication, I have kept Bob's promise.

While no one seemed especially interested in the merits--does Wisconsin's budget fight show that amending the Bankruptcy Code is unnecessary?--the post nevertheless brought out the mob.

Respondents attacked me and each other (sometimes pretty crudely) for, among other things:

Writing about something too "political" for Credit Slips (yes, well, amending the Bankruptcy Code is political, as are state budgets);

Allegedly having a conflict of interest for writing about this at all (not quite: I am not a member of a union, which is what the fight here is about); and

Failing to use apostrophes correctly (sorry, but for some reason the blogging response function doesn't always pick up apostrophes or quotation marks).

While there were plenty of personal attacks, no one really responded to the basic observation in the original post: Why amend the Bankruptcy Code if states have the political will and ability to get their debt under control on their own?

My view is that negotiated debt restructurings usually preserve more value than other ways of dealing with distress. This, of course, is a principle underlying much of the Bankruptcy Code (see, e.g., chapter 11). It would likely be imputed to a "chapter 8" for state bankruptcies--if enacted--as well.

In Wisconsin, Governor Walker has said he won't negotiate with the unions. But all that tells me is that he has more power than a new chapter 8 would likely give him. He doesn't need state bankruptcy.

While I am suspicious of Governor Walker's claim that Wisconsin's fiscal "crisis" warrants severe reductions in public employees' power to bargain collectively, he was duly elected governor in a state with Republican majorities in both houses. I have little doubt that his proposals, unlike Newt Gingrich's on state-bankruptcy, will eventually become law.

Clearly, Scott Walker, Wisconsin’s newly-elected Republican governor, did not get Newt Gingrich’s memo: Walker has figured out how to bankrupt a state without any need to amend the Bankruptcy Code.

As discussed in my post last week, a curiosity of Republican proposals to amend the Bankruptcy Code to permit states to declare bankruptcy is that it probably won’t happen. Even if a Democratic Senate and President approved a new "chapter 8" of the Bankruptcy Code, the Democratic governors of the most profligate debtor-states—California and Illinois—probably wouldn’t use it.

Walker has shown another reason a state bankruptcy amendment won’t become law: It isn’t necessary.

In just a few short months, Walker has allegedly given away hundreds of millions of dollars to wealthy donors, thereby driving up the state's deficit, creating a fiscal "crisis" that some claim didn't previously exist. He cancelled the federally subsidized high-speed rail proposal, apparently costing the state over $800 million in federal funds, a significant number of jobs, and presumably some contract damages. And, most important, he has decided to pay for this by unilaterally cutting middle-class wages for public employees, and eliminating their right to bargain collectively.

Eliminating middle class jobs and breaking unions has certainly been the goal of some bankruptcies. But if, as Walker has shown us, states can do that without bankruptcy, why bother to amend the statute?

If you have followed me this far--and it's understandable if you haven't--you might be curious to know what ultimately came of LoPucki's Big-Bankruptcy Empirical Research Conference, which I "live-blogged" (is that a verb?) yesterday.

The short answer: It's all about jack-knifing and pencils in Zimbabwe.

Huh?

Background: Nothing gets academics’ dander up like debates about methodology. For legal academics, this often breaks into two related clashes. (1) Whether to be an “empiricist” or not; and (2) if so, how to do it.

Rather, the real knife fight was over how to do this work. Must it only be quantitative (and guided by a scientifically legitimate—falsifiable—hypothesis)? Or could (should) it also include (arguably less rigorous) qualitative methods? Does it have to be social science? Or is “good enough for law” good enough?

Regardless of how you define chapter 11 success, selecting the information that should compose a chapter 11 database to help you figure out what works (and what doesn't) is often a much trickier problem than you might think. Consider, for example, the simplest question: what is a “turnaround manager?”

It’s a question you might want to be able to answer, because you might think that they do (or do not) make success (however defined) more likely. The services of the ZolfoCoopers and Alvarez and Marsals of the world don't come cheap. If they aren't improving outcomes, maybe they aren't worth the price.

Yet, we know that the ZolfoCoopers and Marsals are not the only turnaround managers. For example, LoPucki observed that many companies in trouble may simply let senior management go, and “promote some subordinate lackey who is declared to be a turnaround expert.” Is that person a "turnaround manager"?

For those few who don't know, the Bankruptcy Research Database is one of the most important tools available to scholars and practitioners interested in understanding patterns in chapter 11 cases. It captures a great deal of information about essentially every large public company that has commenced a chapter 11 case under the current Bankruptcy Code.

The holy grail of all bankruptcy scholarship is figuring out whether a case was successful. Conventional wisdom might say that confirming a chapter 11 plan—and paying the professionals in full—is good enough.

But, we know that many companies file again, despite having confirmed a plan, and that may not necessarily be evidence that the plan was a failure: circumstances change, etc. Conversely, the confirmed plan may, in hindsight, prove much worse than other possible deals: Perhaps a 363 sale would have produced greater recoveries for creditors.

I have to say that, while I have had many interesting introductions--and Bob has called me many interesting things over the years--"boyfriend" (by implication) hasn't been one of them. (If you find the old Angel's version cloying checkout the Raveonettes').

Whether or not my return is trouble, I am happy to carry the theme forward, and try to scare off several unwanted suitors, in particular some misconceptions about what a state-bankruptcy amendment is really about. In the next few days, I will also live-blog the LoPucki Big Bankruptcy Empirical Conference at UCLA. I also hope to say a few words about the Chapter 11 filing of the Archdiocese of Milwaukee, both because it is sort of in my neighborhood, and because I've written about the church-bankruptcy cases before.

As most bankruptcy observers know, this was the case that was meant to resolve questions about the timing of Bankruptcy Code § 1146(a) (f/k/a 1146(c)): Are Chapter 11 bankruptcy sales tax-exempt no matter when they occur, or must they occur after plan confirmation?

The short answer: On a heavily textualist analysis, Justice Thomas, writing for the majority (Breyer and Stevens dissenting), holds that the tax exemption is available only for sales after plan confirmation.

The decisions itself is, i/m/h/o, probably right. But for the wrong reasons.

In my prior post, I described some data we’ve generated on the somewhat surprisingly infrequent use of examiners in large Chapter 11 cases. I said that in this post, I would offer some thoughts on what is going on here.

Before revealing our theories, I should note that our data are preliminary. Although we have reviewed 650 dockets and hundreds if not thousands of pleadings, we have not yet found strong predictive trends in these data. We have also interviewed nearly 30 lawyers, judges, former examiners and other participants in the bankruptcy system. While these interviews are often illuminating, they are inherently subject to bias. In short: This is all preliminary and subject to change without notice.

A hobby of mine the past couple of years has been an empirical study of the use of examiners in the bankruptcy reorganizations of large, public companies (okay, I admit I have an odd definition of the word “hobby”).

“Examiners” are private individuals who may be appointed to investigate allegations of mal- or misfeasance when a company seeks protection under Chapter 11 of the U.S. Bankruptcy Code. Examiners have played important, sometimes controversial, roles in such recent, high-profile cases as Enron, Worldcom, Refco, Mirant and New Century. Their investigations have sometimes cost millions of dollars and resulted in major lawsuits or settlements.

Well, if the comments are any indication, Tuesday's post--where I discussed articles about problems with home equity lenders pulling their lines and errors in bond ratings--seems to have a struck a nerve. Rather than reply to each, I will reply to all in a general way.

First, a number of comments suggested that I was soft on fraudulent borrowers or too hard on the rating agencies. "Jarhead," for example, admonished that we should "start to sue borrowers." "AMC" doesn't understand why lenders shouldn't be entitled to the full benefit of their contract rights. "Orville R" claims that "nobody, I repeat nobody, for[e]saw [sic] the unprecedented 20% drop in house values." In any case, he suggests, Moody's mistakes were a "non-story" because Moody's ratings simply reflected disagreements among the professionals--in particular the lawyers.

I should be clear that I have no sympathies for any particular type of stakeholder in the mortgage mess. I think no category of participant has a monopoly on cupidity, deceit or incompetence. Thus, I agree that many borrowers who probably knew better (or should have known better) should be held to the bargains they struck. But that's exactly what we're doing. Jarhead's comment that we should sue borrowers ignores the fact that we are: It's called "foreclosure," and the rates of suit are apparently at historic highs.

Thanks to Bob and the other Credit Slips authors for having me back. I hope to post about several different things, some more topical than others. The first may be the most topical of all--the presidential campaign.

Now that Hillary has conceded the Democratic primary to Barack Obama, we are left with a question Credit Slips readers might care about: How will she pay off her campaign debt and—more interesting—what if she can’t?
According to filings with the U.S. Federal Election Commission (FEC), which governs these things, as of the end of May, Hillary’s campaign was about $20 million in the red.
Consider the following scenarios:

1. Hillary's Committee receives contributions sufficient to pay off the debt. This is probably the way the federal election law expects things to work. The problem is that individuals are limited to contributions of $2,300, and there is a long history of unsuccessful candidates—famously, John Glenn--who could not pay off their presidential campaign debts.

2. Hillary's Committee doesn’t receive contributions sufficient to pay off the debt, but Hillary picks up the tab. This is possible, and appears permissible under U.S. campaign finance law. But Hillary already “lent” her campaign $10 million. Why? We don’t know, but presumably so that she could repay herself in the event she was able to raise the money from others.

3. Hillary doesn’t pay off the debt and creditors don’t sue. As a general matter, we like the compromise and settlement of claims, and you might think that this would be as true of campaign debts as others. But in fact—for reasons that should be fairly clear on reflection—federal election law is uncomfortable with campaign creditors who forgive debts. The forgiveness might simply be a way around campaign contribution limits.

4. Hillary doesn’t pay off the debt, and creditors sue. Nothing stops creditors from suing an election campaign committee that doesn't pay its debts, and nothing prevents the committee from commencing a bankruptcy case. But an election committee doesn't generally have assets—unless it has avoidance actions under U.S. bankruptcy law or state law causes of action that might recover payments for redistribution to other creditors.
And this is where things get interesting.

Under McCain Feingold, the 2002 federal law that made important (if controversial) changes to U.S. campaign finance law, it appears that Hillary, as the candidate, has an incentive to pay herself first, before other creditors--even if her Committee is insolvent. Why? Because if she doesn’t do so before the conclusion of the Democratic primary (i.e., the Democratic Convention, in August), her repayment is apparently capped at $250,000 under the so-called "Millionaire's amendment." See11 CFR 116.11(b) (The Millionaire's amendment is being challenged in the Supreme Court on other grounds).

So, it looks like campaign finance law puts a conventional understanding of priority on its head. Here, the “owner” or beneficiary of the Committee—the candidate—would get paid before other creditors. If her Committee were insolvent, and she repaid herself before August, and the Committee is then put into involuntary bankruptcy, can the bankruptcy trustee recover the repayment as a preferential transfer under Bankruptcy Code section 547? Is it akin to a dividend distribution while insolvent, which would be recoverable under state law? Or does McCain Feingold create some kind of defense to these or similar actions?

I’ve written about the uneasy fit between commercial law and campaign finance law, looking in particular at first-amendment (political speech) defenses to fraudulent conveyance actions by insolvent political donors. Jonathan C. Lipson, First Principles and Fair Consideration: The Developing Clash Between the First Amendment and the Constructive Fraudulent Conveyance Laws, 52 U. MIAMI L. REV. 247, 272–303 (1997). Although there is some case law on this, there’s not much. Which suggests that even though campaign committees are often deadbeats, the normal debtor-creditor dynamics—dunning, suit, compromise and/or bankruptcy—do not seem to apply. A recent commentator on NPR observed that "debt retirement is the hardest task in American politics."

So, here are the questions for readers of Credit Slips: What should Hillary and her campaign Committee do? What experiences have you had with campaign finance (or other politically-related) debt? Should we treat political debt differently from, say, home mortgages or commercial paper?

When Credit Slips’ management learned that the Delaware Supreme Court issued a remarkably brief order a couple weeks ago affirming the Chancery Court in the Trenwick litigation, they asked me to reprise my role as guest blogger here. I am, of course, happy to oblige.

Trenwick was the latest in a series of cases at the increasingly congested intersection of bankruptcy and corporate governance. Trenwick involved both breach of fiduciary duty and "deepening insolvency" claims. I won’t belabor the fiduciary duty issues, as I've already discussed them here (you have to scroll to the bottom). Deepening insolvency, on the other hand, warrants a few words.

The basic idea behind deepening insolvency seems simple: Creditors claim they were harmed when the corporation incurred debt which, rather than salvaging the company, merely prolonged the agony, "deepening" the distress. Instead of losing 75% of their claim, for example, creditors might say that the deepening insolvency "misconduct" caused them to lose 85%. Thus, creditors bring a lawsuit against the managers and others who they believe caused this additional loss. The legal issue is whether and to what extent the courts will give the creditors a remedy if they can prove these facts.

Unlike the closely related question of directors' duties to creditors, there is no obvious predicate doctrine which might guide a court trying to determine how to respond to such a claim. Although most analysts trace deepening insolvency back to the 1983 Schacht case from the 7th Circuit, no one has been able to figure out if deepening insolvency is really a unique cause of action that could be asserted against corporate fiduciaries or professionals, a measure of damages, or both, or neither.

The logical problems with the claim are pretty clear. In many cases, incurring additional debt may actually save the company, but of course you won't know this until it’s too late. Moreover, it is not clear what work this deepening insolvency "doctrine" would do that other doctrines—including breach of fiduciary duty, fraudulent conveyance and good faith—could not already do.

These were certainly the views Vice Chancellor Strine expressed—repeatedly—in his ginormous, 90-page, 25,000+ word Chancery Court opinion in Trenwick, which is what the Supreme Court affirmed--in a mere two sentences.

In truth, it is not clear why VC Strine bothered to say much of anything in Trenwick. Many of the plaintiff's claims were obviously problematic, including that the plaintiff clearly lacked standing to sue, and the debtor was evidently solvent at all relevant times. As with Gheewalla and some of the other recent Delaware jurisprudence on these issues, the results are probably correct—the curiosity is in the analysis.

Until the Trenwick Supreme Court opinion, it seems the Delaware courts were saying a whole lot more than was necessary in cases that could easily have been resolved with little discussion. Thus, I recently argued in Stanford's Journal of Law, Business and Finance that Delaware courts appeared to be engaged in the "expressive function" of judging. This is just a fancy way of saying that they have been doing a lot of jaw-boning to try to send messages to their audience—lawyers, directors, etc.—about what is and is not acceptable behavior when a firm is in distress.

Trenwick would seem to be the end of this jaw-boning, although there is clearly more that could be said. After all, we should not forget that the net result of cases like Gheewalla and Trenwick will be that Delaware has foreclosed many doctrinal avenues that creditors might reasonably want to pursue against directors and other corporate actors. In fact, contrary to Vice Chancellor Strine’s Chancery Court analysis in Trenwick, it would appear that, in all but extraordinary cases, neither breach of fiduciary duty nor good faith claims will lie in the wake of Gheewalla and Stone v. Ritter.

Perhaps Trenwick means Delaware has said all it means to say on deepening insolvency (and related matters, such as directors' duties to creditors). Perhaps it means they have gotten (or given) the message—and they are going to keep quiet for a while. Or, perhaps it just means that VC Strine has finally worn the Supreme Court out. Only time--and more jaw-boning--will tell.

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Bankr-L

As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information.
Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service,
membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a
subscription on Bankr-L, click here to visit the page for the list and then click on the
link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL
with a professional bio or other identifying information would be great.